Taxation of Cryptocurrency and other digital assets

What are the proposed regulations for reporting digital asset transactions?

The IRS created the proposed regulations in support of the changes made by the Infrastructure Act to help resolve uncertainties surrounding the taxation of digital asset transactions and to prevent taxpayers from using digital assets to hide income. The proposed rules are part of the IRS’s larger campaign to increase tax compliance, particularly for wealthy taxpayers and large corporations, as well as to close the roughly $688 billion tax gap, of which studies suggest at least $50 billion is due to unreported cryptocurrency transactions. .

On August 25, 2023, the IRS issued proposed regulations regarding information reporting by brokers for sales or exchanges of digital assets. Key highlights of the proposed regulations include:

The definition of a broker will include digital asset trading platforms, processors of digital asset payments, certain wallet providers hosted by digital assets, and persons who regularly offer to redeem digital assets created or issued by that person. Real estate reporting persons, who are treated as brokers for reportable real estate transactions, will be required to include the fair market value of digital asset consideration received by real estate sellers in reportable real estate transactions on filed information returns and issued beneficiary statements. Real estate reporting persons will be required to file information returns and provide beneficiary statements with respect to real estate buyers who use digital assets to acquire real estate in these transactions. The proposed regulations would provide specific rules for determining the amount realized in a sale, exchange or other disposition of digital assets and for calculating the basis of digital assets.

When will the proposed regulations take effect?

Key effective dates for the proposed regulations regarding digital asset transactions include:

The proposed regulations would require brokers to report gross proceeds on a newly developed Form 1099-DA and to provide beneficiary statements to clients for sales or exchanges of digital assets that occur on or after January 1, 2025.

The proposed regulations would require real estate reporting persons, who are treated as brokers for the disposition of digital assets, to report the disposition of digital assets paid as consideration by real estate buyers to acquire real estate in real estate transactions that close on or after January 1. 2025. These real estate reporting persons will also be required to include on Form 1099-S the fair market value of digital assets paid to sellers of real estate in real estate transactions that close on or after January 1, 2025.

The proposed regulations will require brokers in certain circumstances to include profit or loss and basis information for sales that take place on or after 1 January 2026 on their information returns and statements, so that clients have the information they need to prepare their information. tax returns. In such event, brokers will be required to report the basis of certain digital assets acquired on or after January 1, 2023, disposed of on or after January 1, 2026.

Note that although the proposed regulations do not require such information reporting until 2026, certain proposed rules require brokers and taxpayers to keep track of the basis in any digital assets acquired on or after January 1, 2023.

Cryptocurrency rewards received from staking are included in gross income

The IRS ruled that a cash-method taxpayer who deposited cryptocurrency natively to a proof-of-stake blockchain and received additional units of cryptocurrency as rewards when validation occurred, the fair market value of the validation rewards in the tax year must include the gross income. taxpayer obtained dominion and control over such rewards.

Charitable deduction for donated cryptocurrency

The IRS denied a taxpayer’s charitable deduction for donated cryptocurrencies because the taxpayer did not meet the qualified assessment requirement and the reasonable cause exception.

Generally, for a §170 charitable donation deduction in excess of $5,000, a “qualified appraisal” must be obtained unless the reasonable cause exception applies. The IRS ruled that the taxpayer’s use of the value reported by a cryptocurrency exchange on which the donated cryptocurrency is traded does not meet the qualified appraisal requirement or the reasonable cause exception.

Loss deduction for worthless or abandoned cryptocurrency

The IRS has denied a taxpayer’s loss deduction, claiming that his cryptocurrency is either worthless or has been abandoned because it has declined significantly in value.

Section 165 provides a deduction for losses evidenced by closed and completed transactions, established by identifiable events, and actually incurred during the taxable year. The IRS ruled that the cryptocurrency is not worthless because it is still traded on a cryptocurrency and the taxpayer did not take any affirmative action to abandon the cryptocurrency.

State Taxes vs. Federal Taxes

At the state level, crypto taxes bring another important consideration: sales tax. However, most states do not yet have any guidance or legislation regarding the sales tax. Of the few states that do, some, such as California and Kentucky, treat crypto as equivalent to cash in transactions, taxing it to the same standard. In other states, such as Arkansas and Washington, digital currencies are not subject to taxation.

[Explore a Practitioner Perspective Special Report on recent international developments of cryptocurrency’s classification and taxation.]